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The Green Shift - Sustainability Finance In The Canadian Loan Market

The Canadian government has been traversing a green path towards a low-carbon economy for some time. Beginning in 2016, the Canadian government ratified the Paris Agreement and adopted the Pan-Canadian Framework, a federal national climate plan. In late 2020, the Canadian government revamped the federal climate plan[1] and the Minister of Environment and Climate Change tabled the Canadian Net-Zero Emissions Accountability Act[2], which aims to legislate Canada’s target of net-zero greenhouse gas emissions by 2050. These measures have had a ripple effect across Canadian financial markets, as evidenced by the following examples:  

  • In a December 2020 lecture entitled “From Climate Crisis to Real Prosperity”, Mark Carney, former governor of the Bank of England and the Bank of Canada and the current UN Special Envoy on Climate Action and Finance, stated that the “transition to a green economy can be the greatest commercial opportunity of our time” as climate change is ultimately about delivering what society values.

  • In January 2021, the Office of the Superintendent of Financial Institutions (“OSFI”) published a discussion paper that examines the physical, transition and liability risks posed by climate change. OSFI is exploring the role of capital requirements, the supervisory review process and market discipline to help financial institutions and pension plans to be prepared and resilient to climate-related risks. Stakeholders are asked to submit feedback by no later than April 12, 2021.

As Canadian financial markets move forward in order to assist businesses with the transition to a low carbon economy, which requires borrowers, issuers, investors and lenders to focus on sustainable environmental, social and governance (“ESG”) strategies and goals, we anticipate that there will be continued growth and interest in the green and sustainable loan market in Canada in 2021 and beyond. Below we examine the key principles and considerations for green loans and sustainability-linked loans to assist borrowers and lenders with structuring and documenting these transactions.

What are the Leading Industry Principles?

As discussed in our January 2020 legal update entitled “Key Considerations in ‘Green Lending’ and Sustainable Finance”, sustainable finance products are loan instruments designed to reward borrowers that focus on predetermined ESG linked goals. The Loan Syndications and Trading Association (the “LSTA”), the Loan Market Association (the “LMA”) and the Asia Pacific Loan Market Association (the “APLMA”) originally published internationally recognized global Green Loan Principles (the “GLPs”) in 2018 and Sustainability Linked Loan Principles (the “SLLPs”) in 2019 to establish standards and guidelines specific to the sustainable and green loan market to ensure consistency and promote its development. In May 2020, the LSTA, the LMA and the APLMA released updated versions of the GLPs and SLLPs and issued guidance documents for both sets of loan principles (the “Guidance Documents”) to provide practical considerations for structuring and documenting such loans and to promote a more consistent approach to their application.

What are the Core Components of Green Loans?

The GLPs define a green loan as “…any type of loan instrument made available to exclusively finance or re-finance, in whole or in part, new and/or existing eligible Green Projects” which consist of projects that fall within the non-exhaustive categories of eligibility set out in Appendix 1 to the GLPs, such as renewable energy, energy efficiency and pollution prevention and control. Green loans must also align with the four core components outlined in the GLPs, being: (i) the use of proceeds, (ii) the process for project evaluation and selection, (iii) the management of proceeds, and (iv) reporting. For a more in-depth explanation of these components, see “Key Considerations in ‘Green Lending’ and Sustainable Finance”.

What are the Core Components of Sustainability-Linked Loans?

A sustainability-linked loan can be any type of debt financing where there is an economic impact tied to a borrower’s achievement of key-performance indicators or sustainability performance targets (“SPTs”) that are determined by a borrower and a lender prior to the establishment of the financing.

There are four main components of a sustainability-linked loan:

1. Relationship to a Borrower’s Overall Sustainability Strategy

Sustainability-linked loans are intended to complement and enhance a borrower’s existing sustainability strategy. A sustainability-linked loan operates as a “transition tool” as it rewards a borrower for achieving its SPTs by discounting the interest rate margin set forth in its credit agreement. However, if a borrower fails to meet its SPTs, any previous discount in the interest rate margin may cease to be awarded and the borrower may be subject to an interest rate margin premium.

2. Target Setting

A borrower and its lender (or in a syndicated transaction, a lead arranger, sustainability agent or administrative agent, as applicable) will negotiate and set the relevant metrics and SPTs, which must be meaningful and ambitious to avoid ‘greenwashing’ (as discussed below). Methodologies for selecting SPTs can include: (a) ESG metrics and targets included in a borrower’s sustainability strategy or sustainability report, (b) external analysis to establish sector-specific ESG criteria and best-practice performance, and/or (c) verified industry metrics reported against frameworks (such as the Greenhouse Gas Protocol) with verification or evaluation by external reviewers who will evaluate whether the selected SPTs are appropriate for the relevant borrower and that borrower’s industry and whether the SPTs align with existing regulatory targets (such as those targets set forth in The Paris Agreement).

3. Reporting

There is no globally accepted methodology or standard for reporting on SPTs but there are several sustainability reporting methodologies in the market, such as the Global Reporting Initiative’s Sustainability Reporting Standards. For a discussion on the leading ESG disclosure standards and reporting, see our firm’s recent article entitled “Race to the Top: Tracking Efforts to Establish a Global ESG Standard”. Regardless of the methodology chosen, the Guidance Documents recommend that borrowers should report on their SPTs at least once a year and borrowers are encouraged to provide details of their underlying methodology and to make their methodology publicly available.

4. Review

The Guidance Documents indicate that the need for external review is considered on a deal-by-deal basis and the responsibilities of an external reviewer will vary depending on the nature of the transaction and the SPTs. External reviewers can provide input pre- or post-signing.

Where an external reviewer is engaged prior to the signing of a credit agreement, a borrower and its lenders may wish to have the external reviewer: (a) confirm the alignment of the applicable sustainability-linked loan with the core components of the SLLPs, or (b) assess the meaningfulness, credibility and ambition of the selected SPTs.

After the execution of a credit agreement, the SLLPs strongly recommend the engagement of an external reviewer, such as an accounting firm, to validate the borrower’s performance against the SPTs.

How are Green Loans and Sustainability-Linked Loans Different?

The fundamental difference between green loans and sustainability-linked loans is that the proceeds of a green loan must be used for Green Projects. In contrast, the focus of sustainability-linked loans is to incentivize a borrower’s efforts to improve its sustainability profile by aligning pricing and other key loan terms to the relevant borrower’s performance against mutually agreed, material and ambitious, pre-determined SPTs.

What are the Advantages of Green Loans and Sustainability-Linked Loans?

The Guidance Documents reiterate that The Paris Agreement and the United Nations’ Sustainable Development Goals are important drivers behind sustainable financing solutions. As such, companies are increasingly developing ESG goals and incorporating them into their business strategy to meet their sustainable development commitments.

The immediate benefits for borrowers entering into a green loan or a sustainability-linked loan include: (a) a positive impact on the environment, (b) a positive impact on the borrower’s reputation and credibility, (c) strong values-based relationships with stakeholders, (d) access to new markets and a wider and more diverse pool of investors and (e) meeting regulatory and policy targets and commitments.

For lenders, the benefits include: (a) incorporating ESG performance into the credit assessment of borrowers, (b) enhancing a borrower’s ambitions on ESG performance, (c) showing commitment to achieve sustainability goals with a correlated economic impact, (d) promoting sustainable long-term growth and profitability, (e) a positive impact on the lender’s reputation and credibility, and (f) increased ability to attract and retain staff who see sustainable development goals as an important part of their personal and working lives. 

How to Avoid Greenwashing / Sustainability Washing

Greenwashing and sustainability washing are terms used to describe situations where a borrower or project is held out as having green or sustainable credentials, but where such claims are inflated, inaccurate or misleading. The Guidance Documents note that market participants should seek to avoid greenwashing or sustainability washing, as it undermines the integrity of the product and undermines investor confidence.

With regard to green loans, the market can take steps to avoid any allegations of greenwashing by closely adhering to the core components of green loans, with a view to being as open and transparent as possible. Borrowers should consider whether an eligible project will be considered green for the duration of the loan, rather than just at the outset of the transaction, and may want to provide a mechanism to exclude such project during the life of a loan. The parties can also agree to exclude certain projects if there is, for example, new information or a change in circumstances that results in an eligible project no longer being categorized as green.

With regard to sustainability-linked loans, the market can take steps to avoid any allegations of sustainability washing by setting SPTs that: (a) are ambitious and meaningful to the borrower’s business and industry, (b) are tied to a pre-determined performance benchmark on a pre-defined timeline, and (c) apply over the life of the loan. The Guidance Documents also encourage borrowers and lenders to seek external review to ensure the appropriateness of the SPTs and transparency of the data.


Sustainable finance is a new and growing area in Canada and it will continue to gain traction as businesses transition to a low-carbon economy. This movement in the economy will be accelerated with the establishment of the Sustainable Finance Action Council by the Government of Canada as described in its 2020 Fall Economic Statement. The Sustainable Finance Action Council will act as an intermediary between the government and the financial sector and will develop the standards on which investments are to be identified as sustainable.

Each green loan and each sustainability-linked loan will require a case-by-case approach to appropriately set the SPTs, draft the relevant loan documentation and ensure the borrower’s sustainable development goals are met. However, the guidelines set out in the Guidance Documents are useful tools for borrowers and lenders alike and provide a starting point for the establishment of the green and sustainable finance industry in the Canadian loan market.

[1] See “A Healthy Environment and a Healthy Economy”, which was released by Environment and Climate Change Canada in December 2020.

[2] For more information, see “Canadian Net-Zero Emissions Accountability Act” on the Government of Canada website.